Policy and legal review of the Micro Finance Institutions (Development & Regulation) Bill: A new working paper

In response to the Second Micro Finance Crisis in Andhra Pradesh,¬†which took place in October 2010, the Ministry of Finance has proposed a new “Micro Finance Institutions (Development & Regulation) Bill”.¬†A new working paper by Shubho Roy, Renuka Sane and Susan Thomas analyses this bill from first principles of economics and law.

A great deal of traditional work in India, in the field of finance and public policy, has been poorly grounded in terms of logical thinking. A variety of government interventions are proposed, without fully showing the rationale for why a given intervention is valuable. I have often scented a socialistic impulse to intervene in the economy based on some vague notions of being a do-gooder. In addition, of course, there are interventions which cater to one special interest group after another.
I feel it is useful to work in a systematic way. The first task is to identify market failures (if any). All interventions must be considered guilty until proven innocent: an intervention must demonstrably tackle a manifestly visible problem. A useful classification scheme in finance is that all financial regulation falls under the three heads of consumer protection, prudential regulation and systemic stability. It is useful to pose problems under these three categories, then propose interventions which address them. At both levels, we need to move away from ex cathedra assertions towards logic and evidence that demonstrates that there is a problem, and logic and evidence that shows that the proposed intervention solves the identified problem without inducing collateral damage.
In the years to come, we need much higher quality drafting of law in India. This process will be assisted if independent analysis in the economy will critique draft law as has been done by the Roy, Sane and Thomas paper. We need more universities and think tanks who will subject all draft legislation and draft subordinate legislation to such scrutiny. On the government side, a greater effort on the formal rule-making process is required, whereby government is able to utilise such comments more effectively so as to strengthen the work.

Interesting readings

The Anna Hazare silliness is depressing. Writing in the Indian Express, Shekhar Gupta has an interesting angle on why there is so much interest in this snake oil.

India’s $2 trillion economy means we have to reform faster by R. Jagannathan on FirstPost.

Meera Subramanian has a beautiful story about how Diclofenac, fed to cows, is killing off India’s vultures. We’re down from 50M vultures to 60k. The consequences are bigger than we think.

Former Sebi member Abraham?s claims under CVC lens by Appu Esthose Suresh in Mint.

China’s port in Pakistan?, by Robert D. Kaplan, in Foreign Policy.

The 10 most corrupt Indian politicians.

A promising band: Menwhopause. Listen.

The decline of Asian marriage, in the Economist.

Vinayak Chatterjee on ten projects that matter in India today.

The new draft Microfinance Bill. Back story.

Nirvikar Singh in the Financial Express on the CCI order about NSE.

Think again: War by Joshua S. Goldstein in Foreign Policy.

Hegemony with Chinese characteristics by Aaron L. Friedberg, in the National Interest. Arab Spring, Chinese Winter by James Fallows, in the Atlantic. The South China Sea is the future of conflict by Robert D. Kaplan, in Foreign Policy.

The problems of dogs in Iran.

Interesting Readings for December 23, 2009

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New Sources of Financing for Microfinance Assets

The problem

The main source of funding for microfinance in India has been through banks, primarily through the forced `priority sector lending’. Over the years, the demand for funds in the microfinance industry has outpaced the growth in investment by banks. In addition, banks are not the ideal place for these assets, given the nature of cashflows and maturity of micro loans. Hence, even though MFI assets are part of priority sector lending, the excessive focus on bank capital has effectively raised the cost of capital for MFIs.

The upstream funding for microfinance needs to be diversified to harness a diverse array of borrowers, so as to avoid the constraints and unique compulsions of any one source. However, at present in India, MFIs are not permitted to mobilise deposits, or borrow from international lenders, or from MIVs (Microfinance Investment Vehicles).

The role for securitisation

The ideal financing channel for them, in this environment, is securitisation. Through securitisation, a pool of loans across many borrowers (and ideally across many MFIs) would be turned into a tradeable securities that are targets of investment by a diverse array of investors, with different beliefs and compulsions.

A recent transaction

One step towards this goal came about last week, when IFMR Capital announced the completion of a micro-loan securitisation through which mutual fund investment into microfinance takes place. The Rs.480 million ($10.4 million) transaction is backed by over 55,000 micro-loans originated by Equitas Micro Finance, a Chennai-based microfinance institution (MFI) with approximately 700,000 low-income clients.

The bulk of the securities issued were purchased by ICICI Prudential AMC, the country’s third largest mutual fund. The entry of a mutual fund investor into the micro-loan backed securities (MLBS) market, as well as the treasury desks of major Indian banks, has given Equitas a new investor base and lower cost of financing. This should enable lower cost borrowing for the households that Equitas lends to.

Deeper implications

Going beyond the direct issue of access to a large volume of funds at a low cost, capital market financing is beneficial to microfinance firms by bringing about new pressures on transparency, accountability and thus oversight of MFIs.

IFMR Capital has previously done a MLBS transaction, but there it was the sole investor in the BBB rated (subordinated) tranche. In the Equitas transaction, there was investor interest in all tranches; a majority of the BBB tranche was purchased by a private bank. This is relatively new for the Indian corporate bond market, which has hitherto been wary of BBB securities. These developments are thus synergistic for both the growth and development of microfinance and for the corporate bond market.

The ultimate goal is an ecosystem where securitisation paper is constructed using loans made by multiple MFIs, sold to a diverse array of domestic and foreign investors, actively traded on the secondary market, with trading that is supported by high quality disclosure of data about the underlying loans on a daily basis. IFMR Capital will work in all aspects of this ecosystem, including facilitating listing and engaging in market making.

Looking beyond the vision of MFIs funding themselves through securitisation, there is also a role for (say) 1000 small banks (as argued in Raghuram Rajan’s report). A key ingredient of making this work is bringing in market discipline, by having regulations which require them to finance (say) a quarter of their assets using subordinated debt, and using this BBB bond market to exercise market discipline on them. The task of bank supervisors would be simplified when the BBB bond market, the CDS market and the stock market jointly serve up a list of the 50 weakest banks on each trading day. The stock market is in place in India; what is now missing is the BBB bond market and the CDS market.

Further reading

At the IFMR website.

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Grassroots Strategy for Mobile Phone Based Payments, Sighted in Africa

Today’s mobile phones are as powerful as the computer used in Apollo 11 for the moon mission. So how can India’s 400 million-plus mobile phones/NASA computers transform access to finance?

Many people have been talking about the potential of mobile phones to revolutionise payments and ultimately consumer finance. Chapter 3, `Broadening access to finance’, of Raghuram Rajan’s report puts a considerable emphasis on the role that mobile phone companies can have in improving financial inclusion, even though they are not traditionally seen as financial firms. [Also see].

One breakthrough came on 30 June 2009 when the RBI authorised 17 banks to introduce mobile banking services, enabling customers to carry out fund transfer between banks and accounts.

And there are signs that banks are innovating. For example, there’s a Citibank pilot project, reported in the Business Standard a couple of weeks ago, that enables credit card customers to use their mobile phone for payments.

But these are only small steps. The RBI guidelines are still quite conservative, and the Citibank pilot is only for six months and for customers in Bangalore.

What about the hundreds of millions of unbanked people in India who have mobile phones?

A brilliant idea that is used in Africa, where mobile phones are used for money transfers, could be important in India. It’s great for unbanked people, because it doesn’t require a bank account or even a bank. And it enable small transfers to be made to help friends and family, say with school fees, medical expenses or loan repayments. It requires no cooperation from the government.

Here’s how it works, for person A to send $5 to person B

  1. Person A buys a $5 top-up card for his mobile phone from a street vendor or phone kiosk and scratches the card to reveal the top-up code.
  2. Instead of keying in the top-up code, Person A sends it to Person B as an SMS message.
  3. Person B receives the SMS and takes her phone to a local phone kiosk, and sells this top-up code to the local trader.
  4. The local trader inserts the top-up code into his own phone to verify that the $5 top up is valid and pays Person B (a bit less than $5).
  5. The local trader can then sell calls on his phone or use the credit for his own private use.

Essentially, a secondary market in top-up cards has been developed that enables small money transfers to be made quickly and easily.

This informal money transfer system has proved so popular that these top-up cards are now sold among the diaspora in London as a handy way of remitting money to relatives. And Western Union is now planning to roll out a mobile money scheme in Africa to avoid being left behind.

Banks here are also keen to explore the opportunities that new technology provides. Yet regulators remain cautious of the potential of mobile phones for transforming access to finance.

While the legal and regulatory issue wait to be resolved, it would be an interesting experiment to see if an informal transfer scheme, along the lines of the one described in this blog post, would work in India. It would also be interesting to hear comments on what other solutions people are using already to make the most of their pocket-sized Apollo-11 quality computers.

These are small steps, which are a grassroots effort at overcoming problems. The big leap will come when the mobile finance sector is opened more fully to competition and innovation.